Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk. So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. As with many other companies Miji International Holdings Limited (HKG:1715) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Miji International Holdings’s Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Miji International Holdings had debt of CN¥55.3m, up from CN¥33.0m in one year. But on the other hand it also has CN¥58.7m in cash, leading to a CN¥3.37m net cash position.
A Look At Miji International Holdings’s Liabilities
The latest balance sheet data shows that Miji International Holdings had liabilities of CN¥81.3m due within a year, and liabilities of CN¥10.6m falling due after that. Offsetting these obligations, it had cash of CN¥58.7m as well as receivables valued at CN¥101.9m due within 12 months. So it can boast CN¥68.6m more liquid assets than total liabilities.
This excess liquidity suggests that Miji International Holdings is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Miji International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact Miji International Holdings’s saving grace is its low debt levels, because its EBIT has tanked 31% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can’t view debt in total isolation; since Miji International Holdings will need earnings to service that debt. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. Miji International Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Miji International Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
While we empathize with investors who find debt concerning, you should keep in mind that Miji International Holdings has net cash of CN¥3.37m, as well as more liquid assets than liabilities. So we don’t have any problem with Miji International Holdings’s use of debt. We’d be motivated to research the stock further if we found out that Miji International Holdings insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions for free.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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